New norms for independent directors need strict monitoring
The Securities and Exchange Board of India (Sebi) has made several important changes to regulations pertaining to independent directors (IDs). These changes are designed to improve corporate governance by distancing IDs from promoters and managements, and to increase transparency on remuneration for IDs. Under the new regulations, which come into force in January 2022, IDs must be appointed, reappointed, or removed through a special resolution of shareholders. This requires a 75 per cent vote in favour as distinct from an ordinary resolution, which requires only a simple majority. This, in itself, should ensure that IDs are approved by minority shareholders, except in very closely held corporations.
If an ID resigns, the resignation letter must be shared in full. Shareholder approval for the appointment of all directors, including IDs, must also be taken at the next general meeting, or within three months of the appointment on the board, whichever is earlier. The new regulations also require that the process of selecting IDs should be transparent, and fully documented. The nomination and remuneration committee, which selects and proposes candidates for appointment as ID, must define the skills required for appointment as an ID, and explain how a given candidate possesses the required skill set. In addition, the composition of the nomination and remuneration committee has been changed. The committee must now consist of a two-thirds majority of IDs rather than the earlier requirement of a simple majority of IDs. The audit committee must also consist of a two-thirds majority of IDs, and only the IDs on the audit committee are to scrutinise, and pass all related-party transactions.
The eligibility of key managerial personnel (and their relatives), or employees of other companies of the promoter group, for appointment as an ID will involve a cooling off period of three years after retirement, or leaving the group. A cooling off period of one year has also been introduced for an ID transitioning to becoming a whole-time director. However, the regulator is open to the idea of giving more flexibility to companies while deciding the remuneration for all directors (including IDs). This may include profit-linked commissions, sitting fees, ESOPs, and so on, provided the total falls within the overall prescribed limits given in the Companies Act 2013. This could be crucial in the case of attracting talent to a start-up — these can now offer remuneration to directors via ESOPs.
If these regulations are strictly adhered to, it will become more difficult for private promoters to appoint IDs who are too close to the management and hence prone to conflicts of interest. Therefore, it should lead to better internal controls and better governance. This is a good step, as is the proposal to allow compensation to be offered in terms of equity. At the end of the day, anything that is aimed at making capital markets more efficient and strengthening governance should be welcomed. However, the government is also a frequent offender when it comes to appointing IDs with conflicts of interest. A recent report highlighted that out of 172 IDs on the boards of 98 listed public sector undertakings, as many as 86 IDs are members of the ruling political party. It is doubtful if the new regulations will be able to stop this practice. Also the proposals need strict monitoring so that they don’t remain just on paper.